The Dennis Rule Better Management
December 29, 2020
December 29, 2020
Not chasing your equity curve, is be better than your last trade
“The best risk management is not to take a risk at all.” Jack F Cahn, CMT
One of the first things you hear about winning at investing and trading is to let your profits run and cut your losses short. Everyone accepts this as usual. However, they are missing the point.
Richard Dennis sees it this way: “You have to minimize your losses and try to preserve capital for those very few instances where you can make a lot in a brief period. What you can’t afford to do is throw away your capital on suboptimal trades.”
Too many traders pay lip service to what the great ones say, they know it is the truth but fail to understand and act in the same way. To do what Dennis suggests, you need a method, a model that tells you when you have a great trade on the horizon and when all the rest is simply an “average trade” at best.
Poker Analogy Improves Understanding
In the game of poker, the rules force each player to make a bet. These bets are called blind antes. They are made by each player when he is to the dealer’s left in draw or flop-style poker games.
Here is the key and the exact rule Richard Dennis made about trading. There are blind bets in poker because a player can sit there for as long as he likes and not play. He can wait to catch a premium hand before making a bet, a good bet. Here is one of the clearest examples of the impact of money on the player, forced by the “rules of the game.”
If the player antes $100.00, and he is dealt a “5” and “7” unsuited low cards and someone raises the bet before the flop – the draw cards – the odds of him winning or losing are the same. The money has no impact on the odds.
However, human nature will push him to defend his $$100 blind bet. But doing so in this example hand of a “5” and “7” unsuited, which have about zero odds of winning, defending your ante is foolish. The player needs to walk away. But what if the player had been dealt a pair of Aces? A much better hand to win with where the player does not need help from the draw cards.
Human nature could make it worse if our poker player betted large in the past on a “5” and “7” hand where he got lucky and won big? How what is his posture? He may be prone to make a “bad bet” and in a big way. Yet the outcome has nothing to do with his past winning experience making a poor bet.
Placing “defensive bets that have little chance of “catching” a sound card or cards to win is going to lose and break the bank over the long run.
A significant point to understand is that the poker player needs to know what the premium hands are, which ones “stand-alone” can win without any help from the draw or flop cards. Likewise, the trader needs to know the setups that precede the significant winning trade positions.
The trading game has the built-in advantage of not forcing the investor to take a risk; he/she can stand aside until he is 100% certain. You wait for the setup, the precondition you know precedes a winning move for you. That is the hard and fast rule from Richard Dennis – a cofounder of Turtle Trading.
The Everyman Trader is not Helped by Old School Thinking.
Conventional thinking and the typical approach to investment/trading is forecasting price targets and direction followed by calculating risk and reward based on trend and targets.
However, the way the masters use the Dennis Rule, which is direction neutral, looks at the market’s context. The Market Wizards look at the setup- first to judge risk and reward, based on the market’s background.
There are many ways to successfully apply the Dennis Rule that fits your personal risk/reward personality or your fund’s investment policy. But I will only focus on one here because I use it. Personally, it is dramatic in its results and built for the aggressive trader or a hedge fund trader.
There are many reasons why no one else talks about the Dennis Rule. For one, it is not transactionally motivated, so it does not get the attention of the Sell-Side of the industry, nor is it a liquidity provider; it is not based on you the idea that you must be in it to win it. Getting your head around that meaning puts your miles ahead of the majority.
Understanding the method does not matter if you trade mechanical strategies or trade a plan based on advisory or visually trade indicators. The only difference is who or what is seeing the data stream.
Contrary Thinker’s methods and system development are based on the above concept of risk management and opportunity accessment, learn more about TradeStation plugins.
Here is the Dennis Rule put another way, “Stop trading for the average, only trade when it’s a great opportunity.”
To drive home the significance of this idea, you need to contrast it to an industry standard. One of the pioneers of systems trading -Robert Pardo – in his original text said the following:
“Let us consider the plus side of the discretionary trader. It is quite simple. The biggest plus is that, to date, I do not believe that a systematic strategy has yet been created that equals, let alone exceeds, the performance of the greatest discretionary traders.”
If you understand this and accept this as real that a robust trading system or a static assembly-line mechanical plan will not make anyone wealthy, again, you are way ahead of the trading mob.
In other words, you are taking a risk each trade to be average, to make an average win. A good trading plan or a system – the way it is defined and developed by Bob is statistically robust; therefore, they are generic. They are designed to deal with all the significant conditions in the markets, going back over the longest period possible. They are meant to provide the trader with an average winning trade each time he regularly holds a position over the long term.
This goal of Algo-strategy trading is the heart and soul of the system trading school of thought. The industry is happy with this because it is “transactional,” and many system traders do well, not great, but can make money. If your goal is to make an average amount of money each day or week to supplemental income, it is very doable. But you need to understand you are taking a risk not to make riches but only to be average at best, as that is the best you can expect from a robust trading strategy.